David Joy: Fed meeting challenges expectations

Last week's Fed meeting raised a few eyebrows, as it challenged widespread assumptions about the expected timing of the first rate increase.

First, the published forecasts of where the federal funds rate is expected to be by year-end 2015 and beyond was slightly more aggressive than had been forecast previously. Second, Fed Chair Yellen's post-meeting comments as to the anticipated timing of the first rate increase was earlier in 2015 than had been widely assumed.

The yield on the ten-year Treasury note jumped 10 basis points to 2.77% in response, before ending the week at 2.74%. The two-year note also rose ten basis points to end the week at a yield of 0.45%, its highest level since last September.

It didn't take long for Fed watchers to weigh in on whether Yellen's comments were a deliberate indication of Fed intentions, or just an off-hand remark. Regardless, the path of Fed policy remains data dependent, and the timing of the first rate increase will occur when it is satisfied with the extent of improvement in the labor market and inflationary pressures have risen to a point where they can no longer be ignored. Whether that point in time occurs in the first or second half of 2015, or not until 2016, remains to be seen.

Ukraine, economic data closely watched
In the meantime, investors will be focused on the Ukrainian crisis, as well as the economic data at home. Whereas the tensions in Ukraine appeared to ease somewhat last week, allowing stocks to push modestly higher, concerns once again began to rise over the weekend as Russian troop counts began to build along the Ukrainian border.

President Obama is visiting his European counterparts this week to discuss their coordinated strategic response, centered on the imposition of economic sanctions that many believe could push the Russian economy into recession. For Europe, the question of sanctions is more problematic because of its reliance on Russian natural gas, as well as deeper trade ties.

The larger question is whether that will be enough to deter further aggression, never mind a rollback of Russia's annexation of Crimea. If, indeed, President Putin believes the breakup of the Soviet Union was a disaster of major proportions, and desires to create a wider Eurasian political and economic block, it seems unlikely that he will be deterred by sanctions that are of insufficient severity. It is unclear whether the EU is willing to go that far.

After rising 1.4% last week, the S&P 500 started this week to the downside, dropping 0.5% on Monday. The day's headline economic report showed a slight softening in the pace of manufacturing activity in the U.S., according to the Markit preliminary March flash report. This came on the heels of last week's calendar, which was generally supportive of the view that activity was firming while inflationary pressures remained subdued. Regional manufacturing activity in New York and Philadelphia, industrial production, initial jobless claims and leading indicators were all a little better than expected.

The housing data is slightly more mixed. Housing starts were softer, but building permits were stronger than forecast. Existing home sales were in line. And core consumer prices were unchanged at 1.6% year-over-year.

After rising strongly last week, European stocks are also lower to start this week, despite flash PMI reports that showed both manufacturing and service industries continuing to expand in March. Confidence indices scheduled for release later in the week, at both the individual country level and Eurozone in the aggregate, will provide some insight into the state of concern over Ukraine.

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